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    Risk Management in Banking Essay

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    During 2000 BC, the development of banking industry emerged. The exchange of grain or goods between farmers and merchant were termed trading. Bank is financial intermediaries which accepts deposits from general public and organizations and are engaged in lending activities. In other word, banking business is the business of receiving money from the market through deposits and paying or borrowing the fund to the capital market and general public as well.

    Banks undertake various financial activities such as investment banking, private banking, insurance, consumer finance, corporate banking, foreign exchange trading, community trading, future and options trading, money market trading etc. Commercial bank generally accepts deposit from the general public and lends money as loan to households, firms, and government as well through various account types as saving accounts, personal loans etc. Other types of bank are investment bank that collects capital by underwriting or by acting as an agent in the issuance of shares. They do not take deposits from customers. The Australian banking system is liquid competitive and well developed.

    Australian banking industry consists of a number of banks licensed to carry on banking business, under the Banking Act 1959. Under the same act, foreign banks are licensed to regulate their business through a branch in Australia and Australian – incorporated foreign bank subsidiaries. Risk Management:It is one of the most important parts of the management function of organisations. Risk environment should be analysed in order to apply appropriate controlling measures and monitor the effectiveness of the control measures applied. The bank’s management is actively responsible in the development and maintenance of any active risk which needs a careful analysis and its management.

    The Reserve Bank of Australia identifies assesses and manages the risk at both enterprise level and business level i. e top – down level and bottom – up level. 1. Exchange Rate Risk and Mitigation:Banks are involved in multi-currency exchange. A large amount of money is transacted across various countries over the exchange rate.

    It affects the business that does import or export, and it also can affect investors who make international investments. Understanding and managing exchange rate risk is important to all business organisations that are involved in it. Therefore, it is important for them to know the risk and impact associated with the transaction. The exchange rate risk can be mitigated by following strategies:-• Identify the Foreign exchange risk that might impact the business and its sensitivity. • Review the risk management process and evaluate its performance with your expectation.

    • Diversify the risk by merging different strategies. 2. Portfolio Risk and mitigation:It is a situation where the combination of assets or units that are within individual group of investments that fails to meet financial objectives. Portfolio risk can be hedged by the use of financial derivate for example use of options and futures. 3.

    Interest Rate Risk and Mitigation:Interest Rate can be explained as the rate upon which banks grant loans to its borrowers and can also be defined as the rate upon which they pay their depositors the return based on the agreement. The interest rate risk is a situation or the probability that the market interest rates are earned on the investments for example bonds, resulting in their lower market value. The long-term bonds hold higher risk. We can manage the interest rate risk by:-• Modifying the duration of the portfolio with bond futures• Improving the Performance of a hedge with Regression4. Credit Risk and Mitigation:The probability of loss when a borrower fails to repay a loan or fails to make payments on any debt. It is one of the most fundamental types of risk.

    It represents a situation where investor loses his/her investment. If the perceived credit risk is high, the rate of interest that investors will demand for lending their capital will be high. Credit risk is calculated on the basis of the borrower’s overall ability to repay. Few examples of credit risk can be a consumer’s failure to pay the mortgage loan, or his/her credit card balance; a company unable to repay its debt; when a bank fails to return the fund to its depositors can also be termed as credit risk. Quality of risk as the outstanding balance of loan as on the date of default whereas quality of risk is severity of loss. These two are the major components of credit risk.

    Banks should analyse its customers and the rate of interest should be fixed accordingly. In other word, high risk category borrowers should be priced high. Portfolio analysis helps the bank to manage their credit risk. Investment in various sectors helps them compensate and balance their losses. 5.

    Operation Risk and Mitigation:The risks from financial fraud, employee, or any other criminal activity and any event that interrupts business processes are termed operational risk. It is not inherent in financial, system or market – wide risk. It is the risk that results from the breakdown in the internal procedure, people and system. A proper management of Operation Risk results in smooth business continuation, proper disaster recovery planning and managed information security and compliance measures. Operational Risk can be managed by:-• Improving the reliability and effectiveness of business operations and the operation of the risk management framework.

    • Enhancing risk based decision making. • Proper planning and delivery of capital investment. • Educating staffs about the risk. Conclusion:Bank is a financial organisation that accepts deposits from various customers from the market, and is also responsible in lending money to the capital market.

    It operates in a dynamic market and thus, continuously faces various unpredictable challenges. There are various risks associated with the banking industry that includes exchange rate risk, portfolio risk, interest rate risk, credit risk and operation risk. Each of the risks have their own effect on the business procedure. Therefore, banks perform their risk management procedure to minimize or eliminate the risks. Various tools are used in this risk management process such as diversification, currency hedging, regression, portfolio investment etc.

    Reference:? International finance magazine (2013) Retrieve from http://www. internationalfinancemagazine. com/article/Australian-overnight-interest-rates-kept-unchanged. html? Banking and Finance Update (2013)- Retrieve from www. ashurst. com? Annual Report (2013)- Retrieve from http://www.

    rba. gov. au? Operation in Financial Market (2013)- Retrieve from http://www. rba. gov.

    au? International Finance Magazine. (2013). Risk Management In Banking Industries

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